A bad week for banks… Euro-crisis over? Don’t be daft… Gold is still the best insurance…

From James McKeigue, across the river from the City

Dear Golden Jann,

● It was a bad week for banks.

French banks had it worst. A credit rating downgrade and fears over their ability to fund themselves hammered share prices in the sector, as the Greek debt crisis rolled ever on.

British banks had their own worries, as the Vickers report hit the headlines. It recommended that UK banks be split into retail and investment divisions by 2019. Some pundits argued that it didn’t go far enough (including our own Matthew Lynn: Proposed banking reforms should go further. If you are not a subscriber, click here to sign up and receive three free copies of the magazine), but safe to say that it also wasn’t the whitewash that some bankers might have been hoping for.

Then, as if to prove Vickers right, on Thursday, Swiss bank UBS was hit out of the blue by a £1.2bn loss from a ‘rogue’ trader.

● But just as banking seemed at its lowest ebb, the world’s elite policymakers rode to the rescue again. Terrified of a Lehman Brothers re-run on the continent, central banks stepped in to provide the short-term funding that European banks so desperately needed. True to form, markets bounced on the news.

So can we stop worrying about Europe? Don’t be daft, says David Stevenson in Friday’s Money Morning: What to buy when investors lose faith in the latest bail-out. This move “doesn't tackle the real problem in the eurozone. Which is that Greece is bust, full stop. So is Portugal” – which incidentally, just found a load more losses hiding in the autonomous island region of Madeira.

Ireland’s not much better off, and “the finances of both Italy and Spain are looking increasingly iffy”.

All this means that banks with any exposure to these countries are also in the firing line. Sooner or later, they will have to make massive write-downs to their holdings of sovereign debt. And as we’ve already noted, Deutsche Bank chief Josef Ackermann warned last week that many European banks wouldn’t survive if they had to write down “all their sovereign bond holdings to current market values”.

In short, don’t be fooled by the market’s Pavlovian reaction to the latest “sticking plaster” solution. Europe’s fundamentals still look bad.

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Four major financial shocks could hit Britain in the very near future.

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Unfortunately some recent UBS research suggests that a breakup wouldn’t be without pain, says Merryn. “The departure of a weak country from the euro would lead instantly to a range of nasty things including sovereign default (as euro debt is forced into the new currency), corporate default, the collapse and eventual recapitalisation of the banking system, and the collapse of international trade.

“The whole thing would end up incurring a cost of around €9,500-€11,500 per person in the exiting country in the first year (40-50% of GDP) and around €3,000-€4,000 in the following years.

“But that's just for the one departure, which is unlikely. The first is bound to prompt a few followers (if Greece went and you had money in a Portuguese or Spanish bank would you leave it there?). So you have to think of these numbers as starter numbers.”

● It’s little wonder that policymakers are resorting to ever more desperate options to maintain the status quo, says John Stepek. And that’s bad news for investors.

When a government feels the need to cheat its creditors or rob its citizens, it’s usually content with a bit of inflation. “It usually works because human beings are wired in such a way that we find dealing with ‘nominal’ returns a lot easier than ‘real’ (after inflation) returns, so we often forget we’re being robbed.”

A more extreme option is ‘forced borrowing’. This is when states “force taxpayers to lend to their government. California did it in 2009 by adding a premium to the income tax withheld from pay cheques, to be repaid the following year”.

That reassures bondholders, because it reminds them why they lent to governments in the first place. But it’s scary stuff for the rest of us. If governments are prepared to coerce people into certain asset classes, then “you don’t know what they’re going to do next. This is one of the main reasons why markets are so jittery. Nothing is safe.”

That’s why you should “hang on to gold” as insurance. Of course you shouldn’t hold all your wealth in gold. And make no mistake about it, gold can go down as well as up, as we’ve seen over the past week.

But “in a world of ever-changing goal posts, you never know when your ‘safe’ investment might turn risky overnight… This is all part of the reason why buying gold is perfectly rational, despite what economic theorists and the more snobbish financial journalists might argue.”

● Talking of inflation and wealth confiscation, our colleagues over at the Fleet Street Letter have been pondering this story for a while. They reckon we’re heading for a re-run of the 1970s. We sent you their presentation on the topic last week, but if you missed it, we’ll be sending it again later today – take a look at it if you haven’t managed to already.

● Of course, the euro-crisis will also throw up opportunities. On Wednesday, Dominic Frisby highlighted one for currency traders – the pound.

Now don’t get excited. Britain isn’t about to experience a rampant recovery. But nor is the pound the ugliest currency around right now. So Dominic reckons that while sterling will drop against the dollar, it’ll probably rise to around “€1.20 and even €1.25 before you know it”. Of course that’s “no surprise, given the rotten state the continent is in”.

Dominic uses a lot of chartist techniques to analyse currency movements. If you’re interested in learning more about how traders use charts to pinpoint entry and exit levels in various markets, you should check out some of my colleague John C Burford’s online video tutorials. I’d start with his piece on ‘tramlines’.

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